Electricity market for dummies (i.e. politicians)

After months of very silly debate about clean energy, one thing is abundantly clear: the electricity market is evolving much faster than most politicians and commentators can understand it.

To be fair, highly technical issues aren't a good fit with politics in general. The detail is dead boring, so the media focuses on the warring political tribes, and it quickly becomes a breathless commentary about 'which side will win', devoid of crucial context.

So we have outrage-bait like federal MP Craig Kelly saying 'people will die' this winter because of renewable energy. Or shock jock Alan Jones saying the new head of the Australian Energy Market Operator, Audrey Zibelman, is 'ideologically constipated' and should be 'run out of town'.

As I explained last month, the story underneath all this distraction is that wind and solar have already changed the game. As that big Finkel report no one read made clear, 'there is no going back from the massive industrial, technological and economic changes facing our electricity system'.

Ultimately, it's a story about how the whole paradigm of the energy market is transforming.

The old paradigm, the one still lodged in the heads of most politicians, rests on 'baseload' power. The graph below, from a 2016 UNSW study (PDF), illustrates the concept. Coal generators operate 24/7, represented by that slab of blue at the bottom. When we need more electricity, other generators turn on, such as 'intermediate' or 'peaking' gas plants. Those are represented by the yellow part of the graph, rising and falling as required to meet fluctuating electricity demand.

This is the paradigm that existed before large amounts of 'variable' renewable energy, like wind and solar power, entered the picture. It's Grid 1.0 — old, centralised and based around dirty fossil fuels.

Now let's look at Grid 2.0 — a cleaner, decentralised and more flexible system. Although wind has a variable output, it doesn't displace the yellow 'peaking' part of the graph. It displaces baseload. That gives us a new paradigm, an energy market of the future:

Now here's the shift together:

Why do variable renewables replace 'baseload' coal? It has to do with how our electricity market works. Each generator offers electricity to the market, and the cheapest is used first. This is called the 'merit order' dispatch process.

When the wind is blowing, wind power is virtually free because it doesn't have to pay for fuel. So wind farms can bid practically zero. In a market where there's lots of wind farms, coal power stations will be called on less and less. Gas can be ramped up and down quickly in response, but coal power stations are classic 'baseload'. They were designed to run all the time and they're not very flexible.

This means wind plays havoc with coal's business model. The chief executive of the Australian Energy Council, the lobby group for large electricity generators, has written that the Northern Power Station in South Australia closed because 'it couldn't operate commercially given the amount of renewables in the grid'.

A recent report from leading energy analysts RepuTex explains the effect in more detail. As wind is now the cheapest power source, 'large amounts of low-cost wind generation are displacing competing generation, causing such plants to generate less energy, recover revenue less frequency, and eventually exit the market once it is no longer profitable to operate'.

Plus there's another factor at play that squeezes out coal — rooftop solar. When the sun is shining people get electricity from their roof instead of from the poles and wires leading to their homes. So rather than increasing supply, as wind does, home solar panels actually reduce demand on the grid during daylight hours. In fact, they've already shifted the peak to a later time.

If we return to that 'merit order' bidding process, we can imagine the two effects working together. Wind power pushes coal further down the order of generators that will be dispatched. Rooftop solar reduces the amount of electricity needed during the day, which again leaves less room for coal. And the variable nature of both requires a more flexible approach that older coal power stations just weren't built for.

What does all this mean? That coal will increasingly struggle to maintain its position.

Analysing the national electricity market to 2030, RepuTex found: 'With a premium placed on flexible generation that can ramp up or down, "baseload only" generation — irrespective of how clean or dirty it is — is likely to be too inflexible to compete in Australia's future electricity system.'

There's one other thing not explained often enough in this debate — the role of gas in setting electricity prices.

Remember that the electricity generators get used in order from cheapest to most expensive. But here's the catch — the most expensive sets the price for all the bids.

Giles Parkinson, editor at industry news site RenewEconomy, explains it using a folksy analogy even Barnaby Joyce would understand: 'Imagine going into a supermarket and buying five apples for 50c each, and then deciding you want to buy one more. The vendor says that the price of the sixth apple is $10. And you have to pay a total of $60 for all six apples if you want it. That's kind of how the electricity market works.'

In Australia, that sixth vendor asking for an outrageous $10 an apple is a 'peaking' plant that burns gas to create electricity. That means, as Dr Hugh Saddler demonstrated in a recent report, the chief culprit of rising power prices is the rising gas price. And the reason for that is the opening of massive gas export hubs in Queensland, sending Australian gas overseas instead of supplying it to the domestic market.

All of this isn't sexy or inflammatory, but it's the real story of what's going on. Wind and solar are disruptive technologies, upending the status quo. They're cheaper and more attractive to investors, so they'll keep getting built. Meanwhile, the financial incentive for big, slow, inflexible 'baseload' power has dropped away. And gas, not renewables, is what's driving higher wholesale power prices.

All this was hard to imagine five years ago. The energy market is evolving, fast. If only politics kept pace.

Greg Foyster is a Melbourne writer and the author of the book Changing Gears.

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Existing comments

Thanks Greg - anything as clear as this is great to put before VCE students. I might have to re-title it "made simple" rather than "for dummies", though.David Neate | 20 July 2017

A quick thing to note that I didn't have space to include in the article.
One is that the relationship between electricity prices, gas and renewable energy isn't as simple as peaking gas plants being the only driver of rising wholesale prices.
It helps to understand what makes up the average electricity bill in Australia. Environmental policies are the smallest part, about 6 percent of your bill. Actually generating the electricity is 28 percent, and retailing (i.e. selling it to you) is 19 percent. That leaves the bulk of the bill, 47 percent, just to pay for the poles and wires that bring electricity to your house.
As it turns out, the biggest cause of electricity price rises over the last decade has been to upgrade those poles and wires. In some states they were old and needed replacing, but they were also upgraded to meet forecast ‘peak demand’ – the few hours a year, usually during summer, when everyone turns on their air conditioners at once.
The problem was the demand forecasts were wrong, so we’ve spent billions on electricity infrastructure upgrades we might not need. (i.e. 'gold plating' the network)
Rooftop solar reduces peak demand, meaning less money should need to be spent on upgrading poles and wires in the long term. And wind power underbids fossil fuel generators, lowering the wholesale electricity price, which reduces your power bill. But the Australian Energy Market Commission, who set the rules for the power system, argues that as more renewable energy enters the grid, coal power stations will close, and this could increase power bills.
So there is a relationship between renewables and power prices, but it's indirect.
HOWEVER, here's the important part. The way to reduce the wholesale power price is to increase supply. Coal doesn't make sense financial sense anymore - it has massive up-front capital costs and a long asset life. Banks are wary of investing in it, given the likelihood of a future carbon price. Gas leave us reliant on the rising cost of that fuel. Nuclear is expensive and slow to build because of the risk management issues. So that leaves forms of renewable energy - not just wind and solar, but also including hydro and solar thermal etc - as the most viable option for new supply.
This is the argument for the Clean Energy Target - it will provide investment certainty for renewables, increasing supply, and thus lowering power prices compared with doing nothing.Greg Foyster | 20 July 2017

'The electricity market is evolving much faster than most politicians and commentators can understand it.' How true!
Readers would do well to download and watch 'Tony Seba - Disruptive Technologies 2017'.
As Tona Seba points out, governments that are quick to adopt new technologies make their citizens richer. Sadly, the Australian Government is slow to adopt renewable energy technologies and is therefore making Australians poorer. Our politicians need to understand the energy trends if they are to benefit us.
The price of solar panels is heading down fast, in contrast to the price of fossil fuels. The time is fast approaching when our homes will be powered by very cheap solar and the energy stored in cheap and effective batteries. The electricity grid will no longer be needed. Home produced solar power will be cheaper than the cost of the transmission of energy on the grid, even if such energy were free. There's never been a more exciting time to be an Australian, providing our politicans quickly adopt new technologies such as solar, wind and storage batteries. All new vehicles will be electric vehicles by 2025. Do listen to Tony Seba's presentation!Grant Allen | 20 July 2017

And one more thing I didn't get to include.
Grid stability is indeed more complicated with high levels of renewables. There are a range of technical solutions, but it's inaccurate to pretend it's not a problem. There's
a good description here: https://theconversation.com/how-to-get-renewable-energy-into-the-grid-without-losing-power-30961
There's been some bad reporting on this - ABC political reporter Chris Ulmann's first piece claimed the "whole grid could go black", which is ridiculous. But his subsequent pieces stuck pretty close to the Australian Energy Market Operator's reports and were mostly accurate. The Left has gone into outrage mode, but I think his reporting has been pretty good overall - same for Australian Financial Review's Ben Potter.Greg Foyster | 20 July 2017

The folksy analogy doesn't reflect the fact we currently consume our apples and find out the cost later!!!
Electricity is real time - not a commodity you buy and use later, but thats how you pay for it.John | 24 July 2017

A commendable start, Greg, as was your article following Finkel's repoprt. However, it is still far too simplistic, and I speak as an engineer who has had many years in the electricity industry. First of all, it is true that "qualitative" explanations can be a great help to the ordinary citizen (and maybe to politicians), it can't be done properly without numerical arguments that take proper account also of the technologies of the different forms of generation - you have gone some way in this buit not far enough. For example, reference to a typical demand curve is a good start, but your last graph implies all renewables only- not so! what it actually should show is reduction of the level of the baseload component which still comes from non-renewables. Further, wind power is not free of cost, nor is this true for any form of generation, renewable or otherwise. The capital cost, the general operating costs and the maintenance costs have to be built into the price. Space does not permit more detail - of which there is a great deal to be added, including the flaws in the"apple market" analogy. Dennis | 24 July 2017

Thank you Greg - this piece and your additional comments are very useful in assessing why - exactly - the seemingly-constant mantra 'baseload generation,' of those who (apparently) don't know either, is generally unhelpful in this discussion. Always a good thing to have some well-referenced research that can intelligently inform what one already suspected!Richard | 24 July 2017

You are right in saying there is no going back, but at the same time we should have eyes wide open about what we have done, and the costs and benefits of what has happened, and we should avoid making the same mistakes in the future. One of the latter is not to allow coal-powered stations to close with just a few weeks notice! Another is paying huge mounts of tax-payer dollars to one set of energy producers over another mainly in response to Green-Left political pressure and political correctness; hopefully that will now change. In terms of reality checks, energy is and is going to be much more expensive than it has been as a result of current policies,which means we have thrown way a major economic advantage for Australia. And for what: absolutely no effective gain in terms of international pollution levels or advantage in terms of the big climate picture. We have gone way beyond where we needed to be in order to fulfil international obligations and nothing more Australia does beyond those matters at all. So we will have fewer good job and more poverty for essentially nothing! Our major contribution to world carbon reductions will be selling relatively clean coal to India which will have a major impact on their pollution levels and producing gas for the international market to help others move away from dirtier hydrocarbons. Eugene | 24 July 2017

Dennis - in fairness to Greg, he didn't claim that wind power IS free of cost; simply that "wind power is virtually free because it doesn't have to pay for fuel," which is not the same thing. I don't feel apples are being compared with apples here (at $0.50 _or_ $10!)Richard | 24 July 2017

Hi Dennis,
Thanks for the feedback...totally agree it's simplistic. That was deliberate, actually, because otherwise people don't read it or understand it. If you have a good graph that includes those details and is still easy for the layperson to understand then please email it to me at greg(dot)foyster at gmail. It would be very useful for the future.
In my additional comments below the article I've included caveats about how renewables DO have a relationship with price rises and frequency/stability IS an issue...which is more balanced and nuanced than most commentators! Thanks again for constructive feedback :)Greg Foyster | 25 July 2017

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